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Statement on "Window Dressing” in Banks' Reports of Condition by J. L. Robertson, Member of the Board of Governors of the Federal Reserve System before the Legal and Monetary Affairs Subcommittee of the Committee on Government Operations of the House of Representatives October 2, 1963 Mr. Chairman and Members of the Committee: “Window dressing" is a convenient and colorful ex pression and undoubtedly will continue to be used to de scribe the problem that concerns this Committee, but we should be aware that it is a misnomer. A merchant dresses his show window to display attractively the merchandise that is for sale in the store. If the window contains Paris gowns and only inferior copies are for sale inside, in time the merchant would lose the public's confidence and its patronage. What is called "window dressing" in the case of banks' reports of their condition is also deceptive, I am afraid. However, it is less easily detected than the merchant's pretense, and some banks seem to be satisfied that the practice will attract more business and that the decep tion will be noted by only a few. But although its ill effects on banks may be less direct than on merchants, - 2 - eventually it could cause erosion of the banking communi ty's most valuable asset - public esteem and trust. Window dressing by banks has two aspects. It involves, first, deceptive transactions that have no genuine business purpose, and, second, a deceptive balance sheet resulting from those transactions. The main purpose of window dress ing is to display to the public a "report of condition'* (in other words, a balance sheet) that presents the bank more favorably than its normal condition warrants. For those who are interested in the devices employed in window dressing, there is being submitted, for inclusion in the Hearing record, an outline of procedures that have been used. The actual results, however, can be described very briefly. Occasionally a bank uses window dressing to hide the fact that it is in debt, but usually the bank's purpose is simply to look bigger than it is. By various arrangements, a bank with "real" deposits of $900 million, for example, can plausibly inform the world that its de posits are more than a billion dollars, and that conse quently it is the largest bank in the city or State. Natu rally, this distresses its rival with bona fide deposits of $950 million, so the next time it understandably is tempted to window dress, "just to present the true rela tive picture!» This is why window dressing tends to spread; in fact, it is surprising to me how many bankers have earned our praise by refusing to climb on the merry-goround . The impression apparently has been created, in some quarters, that window dressing relates only to reports of condition that banks publish pursuant to requirements of law - the so-called “call reports". If that were true, the problem of minimizing or eliminating window dressing would be relatively simple. But the facts are otherwise, and much harm has been done by intimating that bank super visors could end the practice simply by suitable call re port procedures. This point is cnicial, and I want to explain it as clearly as I can. As long as a bank skirts the criminal false-entry laws, it is free to publish a balance sheet a "report of condition" - whenever it wishes, as of any date it selectsj and in whatever form and size suit its purpose. Most banks are required by law to publish their balance sheets several times a year in a form and as of a date specified by their governmental supervisors. But - 4 - these required publications may be compressed into a few square inches in an obscure corner of a newspaper of.small circulation, while the bank's ’voluntary” .advertisements may be - and often are - large and striking displays, as of dates selected by the bank itself, published in journals with immense circulation among the class of readers the bank is most anxious to reach. Does this begin to suggest the fallacy of the contention, recently advanced, that the window-dressing problem can be readily solved by issuing all calls on a "surprise” basis? Perhaps 1 should make clear that a "call” is issued by a bank supervisor to all banks under its supervision, for a report as of a-prior date. F^r example, the Comp troller of the Currency may inform every national bank, on March 5, that it must promptly submit, to him, and publish in a local newspaper., a report of its condition - a balance sheet in prescribed form, as I said before - as of March 3. That date having already passed, the bank cannot retro actively juggle its accounts or engage in specious transac tions to hide any weaknesses in its actual condition. Un less the bank was able to anticipate the date of the call, this produces an accurate report of its normal condition. - 5 Real understanding of the situation requires knowledge of the origin, the history, and the functions of call re ports. The practice of requiring banks to submit reports of their condition to governmental supervisors, and to pub lish such reports for public.scrutiny, began over a century ago. It began against a background of so-called :,wildcat" banking of a kind that is difficulc for us to envision to day. B^th internal and external controls were scanty; bank ing standards were high in some areas but extremely low in others. A bank's condition might vary greatly from month to month, and bank insolvencies were frequent as a result of over-extensions of credit, other unsound policies, and ’’runs". In these circumstances, unexpected calls for reports of condition served two principal purposes. The supervisor received información that enabled him to decide whether any dangerous trends were developing; if there were, he might dispatch an examiner to make a special examination of the bank or to discuss the facts of life with its board of di rectors . Equally important was the information available to che banking public in the report of condition published in the local newspapers. be remembered. In this connection, two facts must Fifty or a hundred years ago commercial banks' customers were almost exclusively people of sub stance, to use a phrase of the time. Wage earners and white-collar workers-fc&rely had accounts. Typical cus tomers were manufacturers, well-to-do farmers, and whole sale and retail merchants. This was long before the days when 49 of every SO bank depositors were completely covered by deposit insurance. In that era, the. majority of bank customers could and probably did read reports of condi tion, to decide whether the bank looked safe" or whether it might be advisable to shift to a stronger institution. It is important to bear in mind also that, in those days, the bank statements so published in accordance with law were practically the only •'statements that were published at all. In our lifetime’the significance of .required reports of condition lias changed greatly.. Today, I venture to as sert, only a tiny fraction of bank customers pause to read items headed 'Report of Condition of XYZ State Bank...Pub lished in Accordance with Call Made by /appropriate authori ties/ ; instead, they relax calmly in the shelter of Federal - 7 deposit insurance. Those who are interested in the condi tion of a bank - such a3 the treasurers of corporations with millions on deposit - are seldom misled by window dress ing. They know it exists and make necessary allowances, checking against the ^’surprise'-' reports, and often they can directly ask banks for the information they want. For bank supervisors also, call reports are less im portant today as instruments of supervision, Jith extremely rare exceptions, the general condition of a bank does not alter substantially from month to month. Furthermore, supervisors have developed better alternative sources of in formation. During my thirty years of bank supervision, I do not recall a single instance in which a dangerous trend, calling for corrective action, first came co our attention through a call report. But reports of condition today serve one important purpose that hardly existed in 1900. In economic analysis and planning, and particularly in the formulation of mone tary policy, reliable bank statistics are a principal tool. Reports of.condition, I venture to say, are the number one source of these statistics for the American banking industry. - 8 - Fot statistical information of this kind, standardiza tion of reporting dates is of great value. asset and liability categories, seasonal In many bank even intra- weekly - variations are astonishingly large. If reports were called for as of December 26 in one year, Decemb.er 5 in the second, and December 15 in the third, even our skilled statisticians would not bé able to measure, with reasonable accuracy, movements in such basic items as de posits, business loans, and many others. Moreover, since most noiibank statistics to which banking data must be re lated are end-of-mohth figures, variable bank -reporting dates detract considerably from the suitability of banking data for analyses of this character. Even the accuracy of the actual data reported would be better under fixed date reporting than under surprise calls. Bankers have repeat edly informed us that it is most difficult to reconstruct an accurate report of condition retroactively for items not regularly covered in cheir daily trial balances. Because of these difficulties, many banks resort to estimating pro cedures that are often subject to a troublesome margin of error. With fixed-date reporting at the mid-year and year- end, banks could arrange in advance for an accurate tally for each reported item as of the reporting date. Against this background, I return to the fallacy that might be called the "surprise call panacea". Plainly stated, this is the argument that all the benefits of call reports would be retained and perhaps even enhanced and the evils * particularly window dressing ~ would disappear, if all calls were made on a "surprise" basis, vj’hat I have already said suggests some of the weaknesses of that argument. However, to evaluate it effectively, understanding of the actual call report situation is essential. Under section 7 of the Federal Deposit Insurance Act, almost all banks in the United States are required to make four reports of condition annually £o their Federal super visors. banks. The date of such balance sheets is the same for all In actual practice, the regular custom has been to call for two of these reports, each year, on unexpected dates, usually in the spring and fall. The remaining two ordinarily are called for on or about June 30 and December 31 of each year. The latter are the principal source of the financial statistical series that I have mentioned. rfe see, then, that ordinarily there are two "surprise" calls every year. To the extent that publication of re* ports of condition called for unexpectedly are of benefit - 10 - to the public, such benefit is derived from chese calls. (However, in the opinion of at least one Federal super visor, it appears, publication of those surprise call re ports is of little benefit to che public. The Comptroller of the Currency has authorized national banks to omit currenc publication of those reports,, requiring publication only, as an adjunct co the reports thac are customarily called for as of June 30 and December Jl.) The *'surprise call fallacy11 amounts to a contention that all benefits of call reports would be retained and all detriments eliminated if June 30 and December 31 were avoided as dates for the remaining two calls. this is far from the case. Actually, however, As I mentioned, a "call’1 as of December 13 would not prevent banks from window dressing, if they cared to, in preparation for a widely publicised year-en.d voluntary statement. In other words, even if the supervisors called for a report as of December 13, and in that report - because of its unexpected date - there was little or no window dressing, the report that actually comes to the public's attention^ and which is the basis of the semi-official si¿e rating of the bank, would be a voluntary year-end statement, which would contain just as much or as - 11 - little wirido.j dressing as the bank might wish. From that viewpoint, the only zesult of the December 13 call would be to impose upon all banks (including the vast majority that do not indulge in window dressing) the work and expense in volved in the preparation and publication of two year-end statements instead of one. Occasional issuance of an end-of-year call as of a date other than the last business day of December has at least one advantage - it helps to reveal to supervisors and other interested persons the extent of window dressing. demonstrated in 1952. This was Reports of condition were called for as of Friday, L-cember 2o, which, for most banks, was just one business day before the end of the year. It can be as sumed chat since banks are accustomed to December 31 calls, the December 23 figures were noc appreciably inflated by window dressing. Most banks (particularly large banks) published noc only their call reports as of December 23, 1952, as required by law, but also voluntary reports as of December 31 - the latter in more eye-catching form. Comparison of the figures of these two statements just one business cay aparc - was instructive. The hundred largest banks in the country (according to a compilation published in che American Banker) furnish a striking example, - 12 - although similar conditions exist in smaller banks as well. Those hundred banks showed total deposits of $121 billion on December 28, and by che end of December 31 this had in creased to almost $129 billion - a.difference of more than 3 per cent. Among the hundred, nine banks showed deposit in creases, in one business day, of more than 10 per cent. In dividual figures ranged up to a high of 34 per cent expan sion. It is obvious chat most of these increases were due to window dressing. Consequently, last year's experience provided a good picture of the magnitude of the problem. Although window dressing sometimes has been attacked for the wrong reasons, the undesirability of the practice must not be underestimated. It is not a negligible problem. The aggregate volume of window dressing, I suspect, does not vary so greatly, from year to year, as to distort seri ously the bank statistics ye need, but I have no doubt that, although allowance may be made for window dressing, the figures on which we depend would be more realistic and re liable if window dressing could be done away with. In addi tion, there is inequity in a system that enables a bank to pretend to the public that it is the largest in the com munity or State, when in fact it is not. Personally, I - 1J do not: believe banks gain or lose much by this "numbers game", but some banks take it very seriously indeed, and that is why window dressing sometimes threatens to get out of hand as banks try to out-maneuver each other. One is reminded of vihat the Ped Queen said in Through the Looking GI p ^s : ".. ,h?.re, you see, it takes all the running you can do, to keep in the same place. If you want to get some where else, you must run at least twice as fast as that!" Window dressing, then, is an undesirable practice * an untruthful, unfair, wasteful, and misleading device. There is little doubt as to how a good banker would react to a borrower's statement that was inflated to show a more liquid position or a larger volume of business than in fact existed. To the degree these efforts succeed, they result in deceiv ing the public. And, to the degree they are recognized and discounted, they result in raising doubts as to the reli ability of bank statements and of bankers' statements. All bank supervisors, and most banks as well, would like t) see the last of window dressing. But the "all- surprise-cair* approach clearly is not the answer. As I have said, it would impose additional burdens on banks, would not materially improve public understanding, and - lA - might weaken essential statistics rather than improve them. (In fact., an ^11-surprise program actually would eliminate the only existing penalty for window dressing. At present, a bank chat window dresses its ycar-end report pays a larger deposit insurance premium, and this deterrent to window dressing, for uhatevsr it is worth, would be lost if the reouired reports, on which the insurance assessment is based, were called for as of December lu, let us say, rather than December ¿1.) As the Committee may know, a number of efforts actu ally have been made to diminish window dressing. Perhaps the most effective has been moral suasion - efforts to con vince bankers that the practice is morally unworthy, that it could be injurious to the prestige of the banking in dustry - that is, to public confidencc in the ethics of banks - and that the game simply is not worth the candle, in the long rup. In my judgment, moral suasion is not only the most promising avenue toward the elimination of window dressing, but also the most desirable. Because of the complicating factors I have described, I am inclined to believe that the problem could not be solved by governmental fiat with out an excessive degree of regulation and control. - 15 * Actual experience indicates that bankers are prepared to stop this practice "if che other Cellow will". Many are convinced chat competing in window dressing is an unprofit able tug of war, but each participant hesitates to let go for fear that his opponent will carry off the pri-ie. I be lieve ¿hat if the bank supervisory authorities, acting vigorously and simultaneously, would request banks through out the councry co quit window dressing, the likelihood of suc cess would be excellent. But I emphasize that such an ef fort would certainly fail unless it was based on complete cooperacion and coordination, most careful preparation, and determined face-to-facc discussion with the bankers in every cicy where the practice prevails. And after initial success, the supervisors would have to remain alert, to chop off any new sproutings of this unhealthy growth. A supplementary line of approach would be to require call reports to include daily-average figures for important items. This might also be helpful from the statistical viewpoint, although it would add to the reporting burdens of banks - including the majority which do not window dress and it would noc, by icself, prevent window dressing in the year-end balance sheet, and that is where it id prin cipally used. I should like to summarise my ideas on this subject. Uindou dressing is an undesirable practice. Every reason able effort should be made to eliminace ic. Galling for all reports of condition on surprise dates is not a satis factory answer. I believe that bank supervisors are in a position to develop a program, oased on moral suasion, that will enable American banking to rid icself of this detrimental practice. If that is the answer, or if some other effective answer is found, it will be transmuted from a hope to a reality only through painstaking study of this complex question, with full and frank incerchange of ideas and criticisms leading to cooperative action, among bank supervisory agencies and the industry itself. I hope that these conditions will prevail, so that efforts to solve this problem, and the many other problems chat con front bank supervisors, can take place under conditions that offer the greatest likelihood of success. Devices limnlcvcc to "V.'indcw Dross11 Bank, Condition Statement« Called for bv Supervisory Authorities Round-robin exchange of interbank deposits among three or more banks which increases both deposits and cask-equivalent assets to m:.ke the bank appear larger and more liquid than it normally would. At least three banks must participate, since reciprocal deposits between two banks are required to be reported ''net" in official condition report?. Short-term reductions in borrowings, which member banks may offset by larger borrowings on other days of the reserve-comrutation period to maintain the required level of average reserves. This docs not inflate the report's figures, but it does show a debt-free condition in published stateirents of the borrowing bank, although the pay-off of the borrowing may be in the call on the statement date and the loan account of the lending bank may not be reduced. Arrangements with large depositors to increase their deposits temporarily by ¿rawing drafts against their accounts at other banks. These drafts are credited to the customer's account immediately but are in the process of collection on the statement date and arc not charged‘against the "account'at the other bank* until after the state ment date. This transaction may be reversed immediately after the statement date, so that there is no change in the allocation of the depositors' balances in the long run. Very short-term loans to cooperating customers the proceeds of which are credited to the customers' accounts on the statement date and repaid immediately afterward. Similar results may be obtained by purchase of bank acceptances or opon-market paper from brokers or nonbank dealers or by shifting of loan participations among banks. Payment is credited to the seller's account and the drafts usod in payment are in transit on the statement date so that both loan and deposit totals arc inflated. Delayed processing of items presented for collection, or of inter office clearings in a branch system. This is a simple and practically uadetectible way of inflating total deposits and liquid assets and can be accomplished by holding back only a relatively few large checks without disturbing normal processing arrangements and witiiout resorting to collusion with other banks or with cus tomcrs. -2Inflation of Flpuros in "V.)luntftr■" ite^li.shud S'..toi..cnts i»y Methods chat are not Permitted in Official Condition Reports 1. Voluntary statements may include reciprocal interbank balances vlsich arc required to be reported "net" in official reports of coruliticn. 2. Voluntary statements may incorporate the assets and liabilities of foreign branches, which must be excluded from official condition reports. 3. Loan and investment totals and capital accounts may include bad debt reserves and other valuation reserves. They are required to be excluded from totals in the official condition reports of most banks.
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